6 Things Netflix Did Wrong: What You Can Learn

In the space of just a few months, the DVD and video streaming service Netflix has gone abruptly from a pattern of rapid growth to one of losing customers, largely due to a controversial change in pricing model that nearly doubled the cost to subscribers who wanted to keep their current services. The company cut its domestic subscriber forecast for the quarter by 1 million users, and its stock dropped by 27 percent last week in response to the news.

Netflix may yet recover from the mishap, but its recent struggle offers some valuable lessons for other business owners, even small ones. Here are six big mistakes the company made, and what you can learn from them.

1) It didn’t “grandfather in” existing subscribers.
Often, when companies make significant changes to their pricing plans, they’ll allow existing subscribers to keep their existing plans unless they wish to make a switch, in a process commonly known as “grandfathering.” AT&T did this last year when overhauling its data plan: The company eliminated its unlimited data plan and switched to a two-tiered data plan price structure. However, by allowing current customers with unlimited data to keep their existing plans, AT&T avoided most of the backlash that Netflix has received in changing the pricing model for all customers.

2) It claimed to add value when the opposite was true.
Previously, Netflix subscribers could receive both unlimited DVDs and streaming video for a monthly fee of $9.99. Under the new model, customers can subscribe to either DVD rental or instant streaming for $7.99 a month each, but it costs $15.98 to keep both options, a massive price hike. Additionally, just after Netflix announced its new pricing plan, the company lost its rights to license new movies from Starz for its streaming video service — making the service even less valuable to many subscribers. In Netflix’s blog, however, the company’s marketing VP continually stressed the “great value” of the new plans, when simple math shows that’s not the case at all.

3) It raised prices by more than 50 percent in one hit.
Netflix’ new pricing model represents a 60 percent increase in price, which came as a shock to consumers. Even if a price increase is necessary, it makes good business sense to do it gradually, so that customers barely notice. Unless you’re purposely trying to cut your customer base, don’t increase your rates by more than a small percentage at a time unless you’re also adding substantial value to your product.

4) Netflix execs didn’t explain their reasoning or offer an apology in their initial announcement.
Netflix may have had valid reasons for raising its prices. It takes a lot of money to license great content for video streaming: Michael Pachter, analyst at Wedbush Securities, estimated that Netflix’s licensing costs will rise from $180 million in 2010 to $1.98 billion in 2012. Had Netflix executives laid out the reasons for the price hike in their initial announcement, customers might have been more understanding. But by using a matter-of-fact, unapologetic tone, they alienated a large portion of their subscriber base.

5) The company had simple bad timing.
If the economy was booming, many people wouldn’t think twice about paying $15.98 instead of $9.99 a month for a service they use regularly and enjoy. But with an unemployment rate still hovering above 9 percent, companies need to tread carefully when raising prices and shaking up their business models, or risk facing a huge backlash.

6) Netflix responded to the backlash by separating into two brands.
On Monday, embattled Netflix CEO Reed Hastings sent out an announcement about the company’s upcoming plans: Netflix would be separating its DVD rental service into a new company called Qwikster, while the streaming service will maintain the Netflix brand. Judging from the blog post’s responses, most customers were even more annoyed than before: This separation means that people who keep both services will need to deal with two separate membership accounts and movie queues, instead of keeping the existing streamlined system. To make matters worse, Netflix failed to secure a Twitter profile for its new brand: The user currently known as “Qwikster” uses an avatar of a drug-abusing Elmo puppet.